We use cookies on this website, including web analysis cookies. By using this site, you agree that we may store and access cookies on your device. You have the right to opt out of web analysis at any time. Find out more about our cookie policy and how to opt out of web analysis.

Pay and incentives

Workers are generally paid a salary (or wage) as a fixed amount in exchange for their services. However, they may also receive incentive pay, a monetary gift based on their performance. Incentive pay is thought of as one way to entice an employee to continue delivering positive results and may come in the form of a bonus, profit sharing, or commission.

Increased competition affects the pay incentives
firms provide to their managers and may also affect overall pay
structures

Deregulation and managerial compensation are two
important topics on the political and academic agenda. The former has been a
significant policy recommendation in light of the negative effects
associated with overly restrictive regulation on markets and the economy.
The latter relates to the sharp increase in top executives’ pay and the
nature of the link between pay and performance. To the extent that
product-market competition can affect the incentive schemes offered by firms
to their executives, the analysis of the effects of competition on the
structure of compensation can be informative for policy purposes.

CEO pay, often contentious, is the product of
many forces

The escalation in chief executive officer (CEO)
pay over recent decades, both in absolute terms and in relation to the
earnings of production workers, has generated considerable attention. The
pay of top executives has grown noticeably in relation to overall firm
profitability. The pay gap between CEOs in the US and those in other
developed countries narrowed substantially during the 2000s, making top
executive pay an international concern. Researchers have taken positions on
both sides of the debate over whether the level of CEO pay is economically
justified or is the result of managerial power.

A good boss can have a substantial positive effect on the productivity of a typical worker. While much has been written about the peer effects of working with good peers, the effects of working with good bosses appear much more substantial. A good boss can enhance the performance of their employees and can lower the quit rate. This may also be relevant in situations where it is challenging to employ incentive pay structures, such as when quality is difficult to observe. As such, firms should invest sufficiently in the hiring of good bosses with skills that are appropriate to their role.

Studies of independent contractors suggest that
workers’ effort may be more responsive to wage incentives than previously
thought

A fundamental question in economic policy is how
labor supply responds to changes in remuneration. The responsiveness of
labor supply determines the size of the employment impact and efficiency
loss of progressive income taxation. It also affects predictions about the
impacts of policies ranging from fiscal responses to business cycles to
government transfer programs. The characteristics of jobs held by
independent contractors provide an opportunity to overcome problems faced by
earlier studies and help answer this fundamental question.

Challenging jobs and work incentives induce
workers to use their skills but make life difficult for managers

Organizational characteristics and management
styles vary dramatically both across and within sectors, which leads to huge
variation in job design and complexity. Complex jobs pose a challenge for
management and workers; an incentive structure aimed at unlocking workers’
potential can effectively address this challenge. However, the heterogeneity
of job complexity and the inherent difficulty in devising a correct set of
incentives may result in misalignment between job demands and incentivized
behaviors, and in complaints by employers about the lack of skilled
workers.

Spillovers can contribute to team success,
although workers are not compensated for them

Workers can contribute to total firm production
directly through their own output or indirectly through their influence on
the output of co-workers. Workers with positive productivity spillover
effects cause individuals around them to perform better and increase overall
team production. In contrast to the “peer effects” literature, workers with
positive productivity spillovers may not be the workers with the highest
levels of personal output. Such productivity spillovers are important for
team success even though they play only a minor role in determining worker
pay.